Sixth Circuit Finds No Affiliate Aggregation for 36(b), No Private Action for 36(a)

The Sixth Circuit Court of Appeals affirmed a district court’s decision dismissing claims relating to iShares’ securities lending program. The lawsuit was based on a 35% lending fee paid to an affiliate of the funds’ investment adviser, which plaintiffs claimed amounted to “excessive compensation” under Section 36(b) of the 1940 Act and a breach of fiduciary duty under Section 36(a). A claim for the right to rescind the contract because it violated the 1940 Act was dropped on appeal. The district court dismissed the suit last August, ruling that the 36(b) claim was barred by the defendant’s exemptive order permitting the securities lending activities at issue and that the no private right of action exists under Section 36(a). In lieu of filing an amended complaint, the plaintiffs appealed the decision.

With respect to the claim of excessive compensation, the court noted that the SEC had issued an exemptive order allowing iShares to “pay an affiliated lending agent, and the lending agent to accept, fees based on a share of the revenues generated from securities lending transactions and to lend portfolio securities to affiliated broker-dealers,” thus triggering a carve-out provision of Section 36(b). To counter that argument, the plaintiffs claimed that the lending and advisory fees should be aggregated to determine if the investment adviser was receiving “excessive compensation” under Section 36(b). The Sixth Circuit agreed with the Second Circuit’s finding in Meyer v. Oppenheimer Management Corp. that such fees should not be considered on an aggregated basis, and that “[i]f the fee for each service viewed separately is not excessive in relation to the service rendered, then the sum of the two is also permissible.” The appeals court further cited language in Section 36(b) that “[n]o such action shall be brought or maintained against any person other than the recipient of such compensation or payments,” and thus a claim against the investment adviser based on excess lending fees must fail. Lastly, the Sixth Circuit also agreed with the lower court that there is no private right of action under Section 36(a), a presumption that it based on the text (“[t]he Commission is authorized to bring an action . . .”), but also further confirmed with a comparison to the text of Section 36(b) and the provision’s legislative history.